1. Financial Options are a useful tool in the investment community but entail certain risks and obligations. Which of the following best describes the purpose or characteristics of financial options:
A financial options is a derivative of an underlying security. At maturity the option holder is obligated to deliver or purchase the underlying security.
Financial options are used to generate income, hedge price risk and/or speculate on price moments of the underlying security.
Financial options pose significant risks to both parties in the option contract because if, at maturity, the option is "out of the money" both parties to the contract lose money.
Financial options are a relatively new phenomenon in the stock market and are rapidly gaining acceptance with the average retail investor based on their simplicity and known "all in cost" at any given point in time.
2. The current price of a stock is $40, the annual risk-free rate is 4%, and a 1-year put option with a strike price of $45 sells for $7.50. What is the value of a call option, assuming the same strike price and expiration date as for the call option?
$4.26
$5.13
$6.60
$7.02
$7.50